Investing 101 Kentucky Council on Economic Education 08/22/06.

Investing 101

Kentucky Council on Economic Education08/22/06

Power of Compounding

Interest on principal plus interest earned

Rule of 72

Penny a day…or $1million?

The power of compounding was said to be deemed the eighth wonder of the world - or so the story goes - by Albert Einstein. 

Stocks

A share in the ownership of a company. 100,000 shares outstanding in companyYou own 1,000 shares  (100,000/1000) = 1% ownership. 

Types of Stock Common Stock

Entitles the holder to one vote in the affairs of the company and one vote to elect the board members.

Preferred Stock Usually doesn't come with the same voting rights as common

stockholders.  Receive a share of profits before common stockholders.  In the event of company dissolution, preferred shareholders

have a prior claim to assets ahead of common shareholders, but behind creditors.

Stock Classifications Blue-Chip Stocks biggest companies in the country

Growth Stocks A growth company usually spends a lot of money on research and puts all its profits back into the company instead of paying dividends

Income Stocks stable companies that pay higher-than-average dividend

Cyclical Stocks move up or down in sync with the business cycle, i.e., automobile, housing, etc.

Defensive Stocks unaffected by changes in the business cycle,i.e., food, utilities. Etc.

Value Stocks considered undervalued by investors Penny Stocks - low-priced, speculative stocks

Industries and Sectors

Industries - Companies are grouped by industry, based on the products or services they offer. Companies in the airline industry would be Delta, TWA, Southwest, etc. 

Sectors are broad groupings of similar industries. The airlines industry would be part of the transportation sector.

Industries/sectors are used by investors to compare similar companies

Dividends

        Offered by well established companies Paid to investors As cash or stock (usually quarterly) Decided by the Board of Directors Record Date/Distribution Date

Stock Splits 2 for 1, 3 for 1 Reverse splits, i.e., 1 for 2 Example:

Johnny holds 100 shares of GTD, currently valued at $60/share, so he has a $6,000 investment.

GTD announces a stock split of 2 for 1. After the stock split, Johnny will hold 200

shares of stock, and those 200 shares will be valued at $30/share. 200 shares X $30 share = $6,000. (Same value!)

IPO – Initial Public Offerings

First sale of stock by a company to the public.

Distributed through investment bankers in the "primary market”

Buyers (usually institutional investors) of these new shares of stock will sell to the public

Mutual Funds

Mutual fund company Manager Pooled money of investors Investors buy shares of the mutual

fund Good way to get started in investing In the Stock Market Game simulation,

students can buy mutual funds in addition to stocks.   

Bonds

IOU issued (debt securities) Issued by governments and corporations

to raise money Investor is the lender Company/Govt repays principal plus

interest (generally quarterly)

Students cannot invest in bonds in the Stock Market Game.

Forms of Business

Sole proprietorship Partnership Corporation

Public or Private Company?

Private company does not issue stock to the public, only privately.

Public company is a corporation that has "gone public“. 

How do businesses raise capital?

Three major sources of financial capital for companies Retained earnings Debt (loans, corporate bonds, etc.) Equity (stock)

Parent Companies, Brands, Subsidiaries

Parent Company - A company that exercises control over one or more subsidiary enterprises.

Subsidiary - a wholly or partially owned company which is part of a large corporation (parent).

Brand - A name, term, symbol, design, or combination of these that identifies a seller's products and differentiates them from competitors' products, i.e., Taco Bell, Lands’ End, etc.

Mergers and Acquisitions

A merger is a form of corporate acquisition in which one firm absorbs another and the assets and liabilities of the two firms are combined. 

An acquisition is when one business takes possession of another business. This is also called a takeover or buyout.

Mergers are a way for a company to grow faster, to become more efficient, to acquire new product lines, to change its image, or to eliminate a rival.

In many corporate mergers or acquisitions, the shares of one company are converted to shares of the other company.  In other cases, one company simply buys all of the other company's shares. It pays cash for these shares.

Market Exchanges

New York Stock Exchange NYSE Oldest stock market in US Auction market (with brokers on trading floor)

American Stock Exchange (AMEX) NASDAQ (National Association of Securities Dealers

Automated Quotation System), is an electronic market

Over the Counter Bulletin Board (OTBB) for companies that don't qualify to list on the major market exchanges because they are too small or their stock prices too low.

History of Stock Market

May 17, 1792 Buttonwood Tree Agreement NYSE – 1817 Curb trading – AMEX Securities Exchange Act of 1937

Stock Market Crash

October 29, 1929 - Black Tuesday Set off the Great Depression

NPR Audio http://www.npr.org/templates/story/story.php?storyId=4134779

Indices

A stock index is a measure of average stock prices in a group of individual stocks.

Reflect how the market is doing as a group Examples:

Dow Jones Industrials - which tracks 30 blue chip stocks (of well-known companies)

Standard & Poor's 500- which tracks 500 stocks from industrial, transportation, utility and financial companies

Russell 2000- which tracks 2000 smaller company stocks

NASDAQ Composite Index - which tracks all the stocks listed on the NASDAQ, almost 4,000 in all.

The DOW

Dow Jones Industrial Average 30 blue chip stocks A stock market index Most-quoted market indicator

Bull and Bear

Bear market describes a period of time when stock prices are falling.

Bull market is a period when stock prices are generally rising.

Factors Affecting the Stock Market

Health company industry economy Global

Good News/Bad News Microeconomic variables - factors that can

affect companies or industries Macroeconomic variables - factors that

affect the economy Consumer confidence Investor perception

Diversification "Don't put all your eggs in one basket." 

Strategy of spreading your investment dollars across various types of securities, i.e., several industry sectors (e.g., transportation,

technology, airlines, retail, etc.) large and small companies, growth and income stocks, cyclical and non-cyclical stocks, blue chip companies, and international companies. 

In the Stock Market Game, 5 stock minimum rule 30% maximum equity

Supply and Demand

Stock prices change because of supply and demand more buyers than sellers – price goes

up! More sellers than buyers – price goes

down!

Reading an Annual Report

Get from company website or call/write company Chairman of the Board Letter Sales and Marketing 10 Year Summary of Financial Figures Management Discussion and Analysis CPA Opinion

Letter Financial Statements Subsidiaries, Brands and Addresses List of Directors and Officers Stock Price History

from Annual Report Library (http://www.zpub.com/sf/arl/)

Fundamental Analysis

Thorough review of company Product Operating efficiency Management Financial performance

Profit/Loss, EPS, P/E, etc. Position in Industry

Technical Analysis

Used to evaluate the worth of a stock by studying market statistics. Stock and stock market trends Charting

Crunching the Numbers

Book value - This represents the different between the company's assets and liabilities. A low book value (from too much debt) could mean that the company's profits will be limited. However, a low value may also indicate that the assets are underestimated, and that the stock is a good value for potential investors.

Earnings Per Share (EPS) - This represents the company's net profit divided by the  number of shares outstanding.  Analysts typically look for steadily increasing EPS, which shows a pattern of consistent growth.

Crunching the Numbers Price/Earnings (P/E) Ratio - company's stock price

divided by its 12 month EPS. High P/E means high projected earning If a company has a PE of 10, that means that investors are willing

to pay $10 for every $1 of last year's companies earnings. Compare the PE ratios of other companies in the same industry, or

to the market in general, or against the company's own historical P/E ratio.

Beta – quantifies how volatile a stock is compared to the overall market

A stock that rises or falls in value at the same rate as the market has a beta of 1.0.

Beta below 1 - less volatile -- and potentially less risky Beta above 1 - more volatile, meaning that investors might expect

its price to rise or fall more quickly.

Margin

Going on Margin" borrowing money to invest In SMG – pay 7% interest (per annum) for any money spent over

initial $100,000 cash.  Very Risky – not suitable for a long-term, buy-and-hold investor.  Minimum Maintenance   If the Total Equity in your portfolio falls

below 30% of the value of your long and short positions, your team will receive a margin call.  (Note: In a margin call, the computer will automatically sell shares of stock in the portfolio to recoup its losses.)

Short Selling Way to make money in the stock market--particularly during a Bear market

when prices are dropping.  It can also be effective if you know a company is headed in a downward spiral. 

Brokerage loans you stock from inventory You sell the stock you “borrowed” When stock value drops, you “short cover” – buy the stock on the market You give brokerage back their stock you borrowed, and You profit from the differenceShort Sell 100 shares @ $50.00       (you borrow 100 shares of stock

and sell it at $50/share and get                                                      credited with $5,000)

Short Cover 100 shares @ $30.00      (you buy the stock at $30/share and your account is charged $3,000

You return this stock to the brokerYour profit is $2,000. You can lose more than you put in! Students can short sell in the Stock Market Game.

Investing for the Long Term

1) start with a plan

2) understand your risk tolerance

3) diversify

4) keep track of your investments

5) invest for the long term